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Homebuilding: Stabilizing the House of Cards

Mon January 18, 2010 - National Edition
Giles Lambertson

Homebuilding in the United States in the past decade became a gigantic house of cards, which finally collapsed in 2008. Boom went bust and homebuilders still are trying to dig themselves out of the resulting heap. A nationwide search continues for policies and business models that will deal simultaneously with foreclosures, unemployment, tight money and budget deficits.

Expert industry observers cannot say exactly when homebuilding will again become a robust economic indicator. But there seems to be a consensus that the situation won’t deteriorate much further.

“As far as construction goes, it has not been perfectly increasing, but it has been steadily increasing since the early part of 2009. I see 2010 as being a better year,” said David Crowe, chief economist of the National Association of Homebuilders. The statement is underwhelming because 2009 is a remarkably low benchmark.

While new single-family residential construction indeed rose for the sixth consecutive month in November (1.3 percent), overall spending on homes still was 25 percent below November 2008 activity; multi-family residential building for the month was 44 percent below a year ago. General construction spending in November fell 13 percent from a year ago and recorded its lowest annual rate in six years, according to the Census Bureau.

News of pending home sales also is mixed. According to the National Association of Realtors, pending sales fell dramatically in November — a record 16 percent — from October, though pending sales are up substantially from a year ago. That is to say, compared to an admittedly dismal sales period in 2008, pending home sales in November were relatively brisk.

Meanwhile, actual new home sales in November unexpectedly fell 11 percent from October, ending 9 percent below November 2008, the U.S. Commerce Department reported. Ironically, the November sales plunge was attributed in part to government assistance.

When Congress extended the tax credit for new homebuyers and expanded it to include relocating homebuyers, a good many people shopping for a house decided to wait before signing any mortgage papers. Consequently, sales were lower for the period than they might have been had the credit not been extended. Timing is everything in a volatile market.

Government’s Role in

a Rebound

Some of the current debate on sparking a housing turnaround is about the positive and adverse effects of federal intervention in the market.

For obvious reasons, realtors and homebuilders associations supported extension of the tax credit incentive. The economist Crowe called the credit “an important ingredient” in any recovery recipe. Switching metaphors, he added that it is not “a silver bullet. We are so far down we need lots of bullets.”

Cameron Findlay, chief economist of Lending Tree LLC, is another advocate of the tax credit. Findlay believes the credit generally has been a plus. “The tax credit did help stabilize things for those that are entering the market. The extension actually is being very helpful,” Findlay said, ”but there is a limit to how much it can help.”

He noted that if someone is buying a house in a state where home prices are relatively low, $8,000 is a significant factor in the decision to buy. “But where prices are much higher, $8,000 is not a big deal. It is not a big deal in California.”

On the other hand, Dr. Ronald D. Utt, an economics research fellow of The Heritage Foundation, is not especially enamored of the tax credit. Utt believes it to be an artificial stimulant of little long-term value and debatable short-term impact.

“The credit was an awfully expensive way to get a little bit of improvement on a month-by-month basis,” he said. “It didn’t really get anything started. For the most part, the tax credit was a tremendous waste of money.” The original and extended credits are expected to cost some $19 billion in tax revenue by the time the second one expires in April.

The effectiveness of federal cash infusions is disputed. The money has not produced anything resembling a turnaround in homebuilding, and deficits spawned by the tax credit and other interventions are mounting. There’s no doubt the recession — and the homebuilding collapse that helped trigger it — are of historical proportions. Yet interventionist policies of the White House and Congress have been extraordinary as well. Payback from the programs has not met stated expectations.

The highest profile tool pushed by Washington last year was the $787 billion stimulus bill passed with the intent of spurring recovery quickly by pouring money into “shovel-ready” projects and stabilizing state and local governments that otherwise might have laid off teachers and other public employees.

Yet in November, overall joblessness was at 10 percent and most of the stimulus money passed in great urgency hadn’t been spent. While November’s residential construction loss of 3,200 jobs was the smallest monthly decline in some time, construction unemployment overall rose to 19.4 percent in November from October’s 18.7 percent.

Unfazed, Congress is expected this month to enact a second, if smaller, stimulus package. Not everyone thinks that’s a good idea.

“The biggest thing confronting the economy right now and challenging the turnaround in housing is a lengthy process of de-leveraging,” Utt said. “Two years ago, homes became almost unaffordable for the average American. So people went to exotic financing and too much leveraging of resources just to become a homeowner. People simply took on too much debt and now are trying to pay down the debt, or are defaulting, to get their level of debt back to more or less affordable levels.

“Instead of a stimulus package that threw money around here and there and propped up this and that, if you had done an across-the-board tax cut last February much of the money saved would have been used to pay down debt,” the Heritage Foundation researcher said. “De-leveraging would have happened much quicker. Consumer debt has fallen some from its peak, but the ratio of debt to income still is very high.”

Utt believes a tax cut to induce further debt reduction remains a good idea. “It’s not too late, but Congress and the president instead are calling for a second stimulus. They are repeating the mistakes of last February.”

The Case

for Intervention

Duane Musser has a different view of stimulus efforts. Musser is vice president of government relations of the National Roofing Contractors Association. He is lobbying to include two tax rebate programs in the latest congressional jobs bill. Colloquially termed “cash for caulkers,” the Home Star and Building Star programs will reward homeowners and commercial property owners that retrofit buildings with energy efficient materials.

Musser said Building Star — for commercial, institutional and multi-family buildings — would put 300,000 people to work on roofs. The cost? About $8 billion. The home retrofit rebate program would cost another $23 billion.

“Congress obviously is going to be restrained by deficits,” Musser acknowledges, but his association members urgently need to find work and he believes the roofing updates are an effective way to do so.

“Our members in residential repair haven’t been hit as hard as those in new residential construction. On the commercial side, new construction in most areas has come almost to a standstill and retrofit work is also being hurt substantially. I don’t know if I would go so far as to say our members are despairing, but most are pretty close to despair.”

The various federal interventions initiated by the Federal Reserve, the White House, the Treasury Department and various congressional leaders have, by design, disrupted the housing market. Had the market been left entirely alone, corrections in housing supply and demand obviously would have come about more quickly — and painfully. Undercapitalized or overextended companies, homeowners and lending institutions simply would have been allowed to fail while hardier survivors moved ahead.

However, social and political sensibilities in this country aren’t prepared to have government sit idly by in the face of such a collapse. Furthermore, LendingTree’s Findlay pointed out, as a practical matter such unregulated correction would devastate the general economy.

“It would destroy the tax base and add to unemployment,” he said. In his opinion, Washington is properly trying to find a balance that will restore market stability. The difficulty comes in having to constantly stay “in front of the curve” and correctly anticipate the impact of decisions. It hasn’t always worked out.

“There have been a few missteps along the way,” Findlay conceded.

Still Fumbling

for Answers

Crowe, the Home Builders chief economist, cited one misstep: foreclosure policy. “The thing the government is trying to do and not having very much success at is to forestall foreclosures,” he noted. “I am not real optimistic that they have figured out what they should do. If we could stop those homes from flooding the market, the underlying pent-up demands for housing would lead us out of this.”

A $75 billion foreclosure program created by the Obama administration subsidizes qualified homeowners so they can modify their mortgage payments to a payable level. Some 4 million distressed homeowners were expected to benefit from the program over the next three years. However, far fewer homeowners have qualified than were expected to qualify.

Foreclosure numbers indeed are discouraging. Some 2 million homes are targeted for foreclosure this year and another 600,000 homeowners are 90 days or more late in their payments, or are delinquent, and also are expected to face foreclosure, according to Findlay. If the 2.6 million homes “flood” the market, it will forestall new home construction.

Yet Findlay sees a silver lining in the foreclosure statistics. He noted that the ratio of delinquencies and foreclosures, a leading indicator, is looking more favorable. “Delinquencies are continuing to rise but foreclosures are not rising. That means banks are not able to foreclose fast enough or are choosing not to foreclose, letting the consumer stay longer in the house.”

Such forbearance by banks, for whatever reason, could mean fewer foreclosures than expected.

Unfettered supply and demand forces generally characterize an organic marketplace. In good years and bad, inorganic mechanisms, such as interest rate-setting, influence housing market decisions but only in a general way.

In the current market, the intervening mechanisms are more focused and manipulative, such as the recurring tax credits and mortgage subsidies to prevent foreclosures. The direct intervention is not unprecedented but the scope of it seems to be. In some cases, the mechanisms are artificially skewing outcomes.

“I don’t think we are at the point anyone can say confidently what’s going on,” observed Utt. “A lot of people are cherry-picking good deals out of foreclosures so a lot of the market has been distorted by a fairly significant drop in prices. You have some swings up and down due almost entirely to tax credits. There is still a long way to go before we see a legitimate recovery, where people are confident it is a good time to buy without any subsidies.”

The booming housing market of recent years was encouraged by the quasi-governmental agencies Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Their subprime programs opened the door for many homeowners.

However, many of the high-risk loans — which were fostered by these agencies with congressional support — ultimately were defaulted upon. That led to the collapse of 2008. Another agency, the Federal Housing Administration, also has been affected. FHA officials announced last fall that the agency’s reserves have fallen below legal limits because of bad loans, which could mean higher interest rates on FHA mortgages. Clearly, there is plenty of bad paper still clogging the system.

Though supportive of the various “proactive solutions put into place” by Washington leadership, LendingTree’s Findlay sees an unwanted dynamic in at least one artificial stimulant.

“Underlying the entire problem is that the Fed [Federal Reserve] today is the only buyer of mortgage-backed securities,” he said. “The government is synthetically driving down the rates by purchasing those securities.”

When Fed officials quit buying, “the spread on mortgage-backed securities will widen. Still, you want to get the government out of the business of buying those securities. Let investors buy them. Unfortunately, concerns about defaults won’t let investors risk it at this time.”

Findlay noted the Federal Reserve also is using a monetary policy called quantitative easing in which, with interest rates already close to zero, the agency tries to increase money supply by artificially buying financial assets from banks. The hope is to spur lending. “Basically, the policy synthetically drives down rates,” he said. “All of these factors are synthetic, created by the Fed to drive down rates to a level where consumers will want to buy again. But you can’t do that forever.”

Findlay said that LendingTree and similar companies are keeping an eye on new housing starts, with the latest hard data expected Jan. 20. “All of those materials in a house have to be constructed, so housing starts have a large impact on GDP and local economies and create jobs. We are very closely monitoring that.”

Utt believes the situation has about bottomed out. The Heritage Foundation researcher actually sees potential for a housing surge.

“We still need housing prices to come down to an affordable level. More people will buy when prices bear a normal relationship to incomes,” he said. “But we’ve probably reached the bottom. We also probably will stay at the bottom for a while, till people are convinced the economy really is strengthened.

“When confidence does turn around, I wouldn’t be surprised if you see a fairly significant surge in home purchases. There will be a once-in-a-lifetime price discount in housing. For $250,000, a consumer might be able to buy a house that sold for $450,000 two years ago. It will be a moment of affordable housing that might not last for long.”

No one is willing to predict just when a genuine rebound in housing fortunes will happen. Crowe said builders should be “cautious.”

“I would just say that this will be a very slow recovery and builders need to be very cautious about getting too far ahead,” said the Home Builders association economist. “The ones who have survived this far are being very cautious and careful.”

He said a lack of financial liquidity is worsening the situation. “Builders are sort of being restricted even more than they would do on their own because of the inaccessibility of funds for building, for production of materials. If we get a really large housing demand, some builders are going to find it difficult to respond.”

Unfortunately, he doesn’t expect the bank loan situation to change any time soon. “I don’t see an immediate solution. That is another thing the government is trying to do and needs to do.”

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